Opinion: 5 reasons McDonald’s won’t succeed with a new CEO

McDonald’s Corp. shares surged on the news that CEO Don Thompson would be stepping down.

Thompson has presided over a painful period for the hamburger chain, with the stock effectively going nowhere since he took over in mid-2012. In the same period, the S&P 500 Index jumped about 50%.

Investors have been bidding up McDonald’s
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stock on hopes that new leadership — Steve Easterbrook — will rejuvenate the world’s second-largest fast-food chain (after Subway). Are those hopes misplaced? Thompson makes a convenient scapegoat, but it’s hard to blame him for what appears to be a systemic problem with sales and the 67-year-old brand.

I think that, while the outgoing CEO may have had shortcomings, there are just too many problems at McDonald’s for a changing of the guard to matter much.

Here’s why the Golden Arches are still tarnished, and why investors may want to consider using this short-term pop as a chance to sell their McDonald’s stock:

Massive brand challenge: On paper, McDonald’s plan to promote its chief brand officer to CEO as a replacement makes sense. After all, some of the biggest problems for McDonald’s are borne out of the idea that it ranks near the bottom in customer satisfaction for the industry. But rebranding a fast-food restaurant’s menu is incredibly difficult, with Kentucky Grilled Chicken and Burger King’s Satisfries just two examples of “healthy options” that work in theory but not practice. The bottom line is that McDonald’s is synonymous around the globe with fast, cheap food — not quality, healthy food — and changing that narrative is a daunting task.

Global headwinds persist: With some 14,000 restaurants in the U.S., it’s difficult for McDonald’s to expand. That’s why overseas markets are key. In fact, for fiscal 2014, McDonald’s derived less than a third of revenue from domestic operations — about $8.66 billion of $27.4 billion in total sales. So while the U.S. brand challenge is important, the bigger issue is global headwinds. Consider that McDonald’s recorded total revenue of more than $11 billion in Europe, making that continent a bigger money-maker for shareholders than U.S. operations. Given the risk of another recession in Europe and an economic slowdown in Asian markets like China, the global growth outlook for McDonald’s is more pressing than any U.S. rebranding effort.

A strong dollar will persist, too: Also regarding global sales, the company’s quarterly filing noted: “Foreign currency translation had a negative impact of $0.08 on diluted earnings per share.” That is a big deal, because when sales are dropping, you can’t afford the double-whammy of unfavorable currency exchange rates holding back overseas profits even more. But considering the Federal Reserve’s overtures of higher interest rates and Europe’s economic mess, it’s unlikely the U.S. dollar will weaken and create favorable exchange rates in 2015. So even if European revenue rises, currency adjustments will keep McDonald’s in the doghouse.

Profit margins dwindle: McDonald’s is one of the gold standards for the franchising model, but it still operates about 20% of its locations directly. And in the latest earnings report, McDonald’s is showing serious pain in profit margins. “Company-operated” margins narrowed from 17.2% last year to just 14.4% in the fourth quarter. That’s part of a longer-term trend. Much like Wal-Mart Stores Inc.
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McDonald’s tapped into big growth over the years by offering ultra-low prices, but that down-market focus continues to put pressure on profits. It’s hard to imagine one or two premium, high-margin menu items reversing this trend.

Dividend growth is over: Some investors talk up the 3.7% yield and a history of dividend growth. Unfortunately, it’s unlikely that yield will rise over time. Consider that McDonald’s is currently paying $3.40 a year in dividends but projected to earn only $5.09 in earnings per share for 2015, about a 67% payout ratio. The only hope for dividend growth is profit growth. And unless something remarkable happens, profits are unlikely to increase dramatically in the next few years.

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